With all this
blather about green shoots and economic recovery and
new bull market, I thought Id inject a little reality into
the collective financial dialogue. The following are ALL true, all valid,
and all horrifying
1. High Frequency
Trading Programs account for 70% of market volume. High Frequency Trading
Programs (HFTP) collect a ¼ of a penny rebate for every transaction
they make. Theyre not interested in making a gains from a trade, just
collecting the rebate.
an institutional investor has put in an order to buy 15,000 shares of XYZ
company between $10.00 and $10.07. The institutions buy program is designed
to make this order without pushing up the stock price, so it buys the shares
in chunks of 100 or so (often it also advertises to the index how many shares
are left in the order).
First it buys
100 shares at $10.00. That order clears, so the program buys another 200 shares
at $10.01. That clears, so the program buys another 500 shares at $10.03.
At this point an HFTP will have recognized that an institutional investor
is putting in a large staggered order.
The HFTP then
begins front-running the institutional investor. So the HFTP puts in an order
for 100 shares at $10.04. The broker who was selling shares to the institutional
investor would obviously rather sell at a higher price (even if its
just a penny). So the broker sells his shares to the HFTP at $10.04. The HFTP
then turns around and sells its shares to the institutional investor for $10.04
(which was the institutions next price anyway).
In this way,
the trading program makes ½ a penny (one ¼ for buying from the
broker and another ¼ for selling to the institution) AND makes the
institutional trader pay a penny more on the shares.
This kind of
nonsense now comprises 70% OF ALL MARKET TRANSACTIONS. Put another way, the
market is now no longer moving based on REAL orders, its moving based
on a bunch of HFTPs gaming each other and REAL orders to earn fractions of
five billion shares trade per day. Take away HFTPs transactions (70%)
and youve got daily volume of 1.5 billion. Thats roughly the same
amount of transactions that occur during Christmas (see the HUGE drop in late
December), a time when almost every institution and investor is on vacation.
HFTPs were introduced
under the auspices of providing liquidity. But the liquidity they provide
isnt REAL. Its largely microsecond trades between computer programs,
not REAL buy/sell orders from someone who has any interest in owning stocks.
In fact, HFTPs
are not REQUIRED to trade. Theyre entirely for profit enterprises.
And the profits are obscene: $21 billion spread out amongst the 100 or so
firms who engage in this (Goldman Sachs (GS) is the undisputed king controlling
an estimated 21% of all High Frequency Trading).
So IF the market
collapses (as it well could when the summer ends and institutional participation
returns to the market in full force). HFTPs can simply stop trading, evaporating
70% of the markets trading volume overnight. Indeed, one could very
easily consider HFTPs to be the ULTIMATE market prop as you will soon see.
TAKE AWAY 70%
of MARKET VOLUME AND YOU HAVE FINANCIAL ARMAGEDDON.
2. Even counting
HFTP volume, market volume has contracted the most since 1989 Indeed,
volume hasnt contracted like this since the summer of 1989. For those
of you who arent history buffs, the S&P 500s performance in
1989 offers some clues as what to expect this coming fall. In 1989, the S&P
500 staged a huge rally in March, followed by an even stronger rally in July.
Throughout this time, volume dried up to a small trickle.
explode higher on next to no volume and crap fundamentals you run the risk
of a real collapse. I am officially going on record now and stating that IF
the S&P 500 hits 1,000, we will see a full-blown Crash like last year.
3. This Latest
Market Rally is a Short-Squeeze and Nothing More. To date, the stock market
is up 48% since its March lows. This is truly incredible when you consider
the underlying economic picture: normally when the market rallies 40%+ from
a bear market low, the economy is already nine months into recovery mode.
Indeed, assuming the market is trading based on earnings, the S&P 500
is currently discounting earnings growth of 40-50% for 2010. The odds of that
happening are about one in one million.
A closer examination
of this rally reveals the degree to which junk has triumphed over
value. Since July 10th:
+ The 50 smallest
stocks have outperformed the largest 50 stocks by 7.5%.
+The 50 most shorted stocks have beaten the 50 least shorted stocks by 8.8%.
Why is this?
rally has largely been a short squeeze.
the short interest has plunged 72% in the last two months. Those industries
that should be falling the most right now due to the worlds economic
contraction (energy, materials, etc.) have seen the largest drop in short
interest: Energy -90%, Materials -94%, Financials -86%.
In simple terms,
this rally was the MOTHER of all short squeezes. The fact that it occurred
on next to no volume and crummy fundamentals sets the stage for a VERY ugly
4. 13 Million
Americans Exhaust Unemployment by 12/09. A lot of the bull-tards in the
media have been going wild that unemployment claims are falling. It strikes
me as surprising that this would be true given the fact that virtually every
company that posted the alleged awesome earnings in 2Q09 did so
by laying off thousands of employees:
+ Yahoo! (YHOO)
will cut 675 jobs.
+ Verizon (VZ) just laid off 9,000 employees.
+ Motorola (MOT)
plans to lay off 7,000 folks this year.
+ Shell (RDS.A) has laid off 150 management positions (20% of management).
+ Microsoft (MSFT) plans to lay off 5,000 people this year.
claims are falling, that means people are finding jobs right? Wrong. It means
that people are exhausting their unemployment benefits. When you consider
that there are 30 million people on food stamps in the US (out of the 200
million that are of working age: 15-64) its clear REAL unemployment
must be closer to 16%.
slowly running out of their government lifelines.
The three million
people who lost their jobs in the second half of 2008 will exhaust their benefits
by October 2009. When you add in dependents, this means that around 10 million
folks will have no income and virtually no savings come Halloween.
Throw in the
other four million who lost their jobs in the first half of 2009 and youve
got 13 million people (counting families) who will be essentially destitute
How does this
affect the stock market?
The US consumer
is 70% of our GDP. People without jobs dont spend money. People who
are having to work part-time instead of full-time (another nine million) spend
less money than full time employees. And people who are forced to work shorter
work weeks (current average is 33, an ALL TIME LOW), have less money to spend.
makes a big deal about earnings (earnings estimates, earnings forecast, etc),
but when it comes to economic growth, sales are the more critical metric.
Companies can increase profits by reducing costs temporarily, but unless actual
top lines increase, there is NO growth to be seen. No revenue growth means
no hiring, which means no uptick in employment, which means greater housing
and credit card defaults, greater Federal welfare (unemployment, food stamps,
So how will
corporate profits perform as more and more consumers become part-time, unemployed,
or destitute? Well, so far profits have been awful. And thats BEFORE
we start seeing millions of Americans losing their unemployment benefits.
With the S&P
rallying on these already crap results
what do you think will happen
when reality sets in during 3Q09?
5. The $1
QUADRILLION Derivatives Time Bomb. Few commentators care to mention that
the total notional value of derivatives in the financial system is over $1.0
QUADRILLION (thats 1,000 TRILLIONS). US Commercial banks alone own an
unbelievable $202 trillion in derivatives. The top five of them hold 96% of
By the way,
the chart is in TRILLIONS of dollars:
As you can see,
Goldman Sachs alone has $39 trillion in derivatives outstanding. Thats
an amount equal to more than three times total US GDP. Amazing, but nothing
compared to JP Morgan (JPM), which has a whopping $80 TRILLION in derivatives
on its balance sheet.
Bear in mind,
these are notional values of derivatives, not the amount of money
at risk here. However, if even 1% of the $1 Quadrillion is actually
at risk, youre talking about $10 trillion in at risk.
What are the
odds that Wall Street, when allowed to trade without any regulation, oversight,
or audits, put a lot of money at risk? I mean
Wall Streets track
record regarding financial instruments that were ACTUALLY analyzed and rated
by credit ratings agencies has so far been stellar.
After all, mortgage
backed securities, credit default swaps, collateralized debt obligations
those vehicles all turned out great what with the ratings agencies, banks
risk management systems, and various other oversight committees reviewing
that derivatives which have absolutely NO oversight, no auditing, no regulation,
will ALL be fine. Theres NO WAY that the very same financial institutions
that used 30-to-1 leverage or more on regulated balance sheet investments
would put $50+ trillion at risk (only 5% of the $1 quadrillion
notional) when they were trading derivatives.
If Wall Street
did put $50 trillion at risk
and 10% of that money goes bad (quite a
low estimate given defaults on regulated securities) that means $5 trillion
in losses: an amount equal to HALF of the total US stock market.
This of course
assumes that Wall Street only put 5% of its notional value of derivatives
and only 10% of the derivatives at risk go bad.
Do you think
those assumptions are a bit